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Title: Does Tax Competition Tame the Leviathan?

Author(s): Marius Br�lhart and Mario Jametti

Publication Date: October 2007

Keyword(s): direct democracy, fiscal federalism, government preferences, optimal taxation and tax competition

Programme Area(s): Public Economics

Abstract: We study the impact of tax competition on equilibrium taxes and welfare, focusing on the jurisdictional fragmentation of federations. In a representative-agent model of fiscal federalism, fragmentation among jurisdictions with benevolent tax-setting authorities unambiguously reduces welfare. If, however, tax-setting authorities pursue revenue maximization, fragmentation, by pushing down equilibrium tax rates, may under certain conditions increase citizen welfare. We exploit the highly decentralized and heterogeneous Swiss fiscal system as a laboratory for the estimation of these effects. While for purely direct-democratic jurisdictions (which we associate with benevolent tax setting) we find that tax rates increase in fragmentation, fragmentation has a moderating effect on the tax rates of jurisdictions with some degree of delegated government. Our results thereby support the view that tax competition can be second-best welfare enhancing by constraining the scope for public-sector revenue maximization.

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Bibliographic Reference

Br�lhart, M and Jametti, M. 2007. 'Does Tax Competition Tame the Leviathan?'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=6512